"It is unlikely that China will adopt a currency and monetary tightening in the same quarter, we push forward our expectation for a revaluation/band increase to Q3," Laidi added.

Analysts at J.P. Morgan agreed.

"There is an ambiguity of what this signals for the yuan," they said. "It could be seen that the Chinese will be less averse to a further tightening through the exchange rate if they believe that monetary conditions need to be more restrictive."

The Chinese central bank said Thursday it was raising its key interest rates in an effort to slow explosive loan growth and cool investment in the world's most populous country.

It was the People's Bank of China's first rate hike since October 2004 and comes against a background of a rapidly-expanding economy which has been fueled by low interest rates and easy investment terms. Those conditions have raised concerns that an investment bubble could be inflating.

The rate hike will take the 1-year benchmark rate, which applies to nearly half of all loans in China, to 5.85% from 5.58%. The People's Bank of China also lifted its other official lending rates.

"The increase in the lending rate is aimed at further strengthening the fruits of macro controls and keeping solid momentum for the economy to grow in a continuous, rapid, coordinated and healthy manner," the bank said in a statement on its web site. See full story.

"It's clear that they want to shift to more domestic demand driven growth and I think the rate hike is only part of the equation and they're going to continue to put in measures to slow demand in the industrial sector," said Naomi Fink, currency strategist at BNP Paribas.

MG Financial's Laidi also noted that China wants to "show the world that it's not all about currencies and revaluation," China "is also serious in liberalizing its financial markets via currency flexibility and monetary policy liberalization."

China revalued the yuan by 2.1% last July and allowed the yuan to move as much as 0.3% daily against a basket of currencies.

But since the big move in July, the yuan has gained only about 1.2% against the dollar, greatly frustrating U.S. politicians who argue the Chinese currency remains undervalued by as much as 40%.

Some analysts speculated that a rate hike may pave the way for a currency revaluation.

"It might be a sign that the government expects the yuan to appreciate," said Li Jin, an assistant professor of finance at Harvard Business School. "This would be the right time for the Chinese government to do that. China is trying to prepare for that scenario."

Nick Bennenbroek at Brown Brothers Harriman called China's move "relatively marginal" and said it "reinforces" but doesn't change the existing trend that the "Chinese authorities have allowed the currency to appreciate gradually."

The Japanese yen initially rallied against the dollar and euro after the news from China, though the gains fizzled ahead of Federal Reserve Chairman Ben Bernanke's much-awaited testimony. The yen, viewed as a proxy for the Chinese yuan, usually strengthens when speculation about yuan move rises.

The yen surged to a three-month high against the dollar later in the session as the greenback slumped after Bernanke said the Fed may pause in its rate-hike cycle and the U.S. current account deficit is a big concern.

"Interest rate hikes will only impact dollar/yen in so far as to what extent the market expects the People's bank of China to follow up" with a currency revaluation, MG Financial's Laidi said.

"Once markets realize the Chinese move mainly consisted of an embryonic tightening that remains far from reigning in China's expansion, we expect the yen to regain its form."

Claudio Piron, forex strategist at JPMorganChase Bank, agreed, saying that PBOC's decision should not have a big impact on financial markets.

"The last three monetary tightenings did not have any consistent or material impact on Asia FX, equity or commodity performance," Piron said.

As for the yuan, "with a non-convertible capital account the PBOC can still divorce its FX policy of gradual appreciation from its interest rate policy directed at excessive domestic liquidity," Piron said, in a note.

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